Defence stocks to watch when geopolitical tensions rise

Why are defence stocks popular?

Defence stocks are a popular choice as they’re known to withstand downturns and experience growth when geopolitical tensions rise.

Defence spending is often considered essential by governments around the world, which means the companies involved in the industry tend not to experience fluctuations in the same way as other sectors when there's a crisis or recession. Some even regard it as a defensive industry – one that isn’t impacted by the business cycle.

For example, the global arms industry was among few sectors that was resilient in the face of the Covid-19 downturn. While the economy contracted by 3.1% in 2020, arms sales increased according to research by SIPRI. The organisation attributes this to three main reasons:

1. Expansionary fiscal policies. Military suppliers saw increased demand for goods and services
2. Government mitigation measures. US states in particular rolled out accelerated payments and orders to reduce the impact of lockdowns on arms companies
3. Contract duration. Military contracts tend to span several years, which makes them less susceptible to shorter-term volatility

Perhaps unsurprisingly, defence stocks are also a popular choice when geopolitical tensions rise. The companies that have high portions of their revenue generated through arms and military services become a means of diversifying against the volatility the rest of the global economy could experience.

If we take a look at the current Russia-Ukraine conflict, we see this playing out in real time. On the morning of February 24, Russia declared war. This already has created an uncertain environment for the majority of global markets – as global indices fell, oil soared on supply fears and gold rallied as money flowed into the safe haven.

But many defence stocks already anticipate that their bottom lines will increase. For example, BAE Systems – the UK’s biggest weapons maker – has said the ‘complex threats’ would boost its business. Its shares rose by 2.6% in early trading on Thursday 24.

For more on how the Russia-Ukraine conflict is impacting markets, visit our news section.

US defence stocks to watch

The US spends the most on defence, totalling approximately $728 billion per year. According to the World Bank, that’s 3.7% of its GDP as of 2020. Given the sheer enormity of the US Government’s defence budget, it’s perhaps no surprised that 10 of the top 20 defence stocks by sales are US-based.

Let’s take a look at some of the biggest companies in the US defence sector.

Lockheed Martin

Lockheed is the largest defence company in the world, a title it’s held since 2009. It’s the lead contractor for the F-35 Joint Strike Fighter, and is a world-leading producer of fighter planes, high-tech missiles and electronics.

Lockheed makes around 89% of its revenue from arms sales, totalling $67 billion in 2021. Net earnings for 2021 were $67 billion, helped by strong performance from its ship and helicopter unit. Full-year earnings per share were $22.76, coming in above analyst estimates of $22.44.

The company is currently set to acquire Aerojet Rocketdyne for $4.4 billion but the purchase has raised anti-trust concerns from the US Federal Trade Commission.

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Raytheon Technologies

Raytheon Technologies is a multinational aerospace and defence conglomerate, which primarily develops technology products and services for projects led by other contractors, such as radar systems, electronic warfare products and missiles.

It was formed by the merger of Raytheon Company and United Technologies Corporation in 2020.

The company saw full year 2021 sales of $64.4 billion, with an earnings per shares of $4.27. It’s worth saying that of the two companies, the United Tech side saw the biggest growth. But there are expectations that within a decade the newly combined business could emerge as the US’s leading aerospace company.

In Q4 2021, Raytheon completed the acquisitions of FlightAware and SEAKR Engineering, which the firm believes will enhance its core space business. 

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Boeing

Boeing is most widely known for its commercial airplanes – whether that reputation is positive or negative is up for debate. But its defence business puts it squarely in the top 5 largest companies in the industry.

The company has a variety of government contracts for aircrafts and helicopters – including its F-15 and F/A-18 models – as well as space projects, such as satellites, launching systems, the International Space Station and the X-37B. In recent years, the scope of Boeing’s business has also expanded into autonomous submarines.

Boeing’s revenue for FY 2021 was $62.286 billion, up from $58.158 billion in 2020. Of this, $26.540 billion was generated from its defence, space and security segment, although the arm of the business did see reduced demand in Q4.

Boeing has secured a contract extension for Future Logistics Information Service in the UK and completed its first tests for the MQ-25 unmanned aerial tanker. 

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Northrop Grumman

Northrop Grumman is a manufacturer of stealth bombers and nuclear products including missiles, bombers and submarines. It is a major subcontractor on Lockheed's F-35 and produces drones such as the Global Hawk.

Northrop Grumman recently developed a new version of Lockheed Martin’s SEWIP Block system that enables the Navy to detect missile threats. If the SEWIP Block 3 can be scaled appropriately, Northrop could sell 200 units, more than twice its predecessor. This could give the company profits of $1 billion according to estimates.

The company has also been awarded a $341 million contract to develop the US Space Force’s Deep Space Advanced Radar Capability to track active satellites and debris in high orbits.

In its Q4 2021 earnings, the company reported full-year sales totalling $35.7 billion, an increase of 3%.

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General Dynamics

General Dynamics is primarily a military shipbuilder, but it has an extensive portfolio of tanks and land vehicles, as well as owning one of the largest defence-focused IT services. It’s one of the biggest contractors for the US Army.

The diversified nature of GD has given it a strong position. The company reported strong order figures for its aerospace division, alongside its marine business, which resulted in revenue of $38.5 billion for FY 2021.

In its outlook, management states that it expects these units to continue to perform as demand from governments and businesses increases.

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UK defence stocks to watch

As of 2019, the UK was the second largest exporter of defence goods and services behind the US – with contract orders totalling £11 billion.

Let’s look at the two biggest UK defence stocks by market cap.

BAE Systems

BAE Systems is the UK’s (and Europe’s) largest defence company. It also ranks in the top 30 FTSE 100 companies by market cap as of February 24.

BAE has five main areas of business: electronics – including navigational and warfare systems – aircrafts, maritime – such as ships, submarines, radars and torpedoes – cyber and intelligence, and platforms & services.

The company’s pre-tax profit for 2021 rose to £2.11 billion from £1.60 billion the year before, as revenues grew by £0.2 billion up to £19.52 billion. This comes as order intake increased up to £21.5 billion.

BAE expects annual sales to keep growing at a rate between 2-4%, and then some if a major conflict in Europe increases defence spending.

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Rolls Royce Holdings

Rolls Royce is one of the largest developers and manufacturers of power systems for use on land, at sea and in the air. The company primarily develops engines for combat jets, helicopters, transporters, trainers and aircrafts, as well as control systems and equipment.

It is the second largest aero engine manufacturer in the world, powering 25% of the world’s fleet according to the Defence Industry Reports.  

Rolls Royce participates in two of the largest combat programmes: the Eurofighter Typhoon and the Joint Strike Fighter F-35. In 2021, the company also secured US contracts to replace the B-52 engine replacement.

The company’s FY 2021 results saw underlying revenues of £10.9 billion, driven by strong performance from both its Civil Aerospace and Defence units. The company expects is profitability to continue in the defence segment as demand for products increases.

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EU defence stocks to watch

In 2021, EU defence spending hit record highs of nearly €200 billion ($225 billion), although collaborative spending has fallen, meaning there is less joint equipment procuring as a bloc.

Let’s look at the largest Trans-European defence stock.

Airbus

Airbus is a European multinational aerospace company that designs and manufactures both civil and military products. The company’s prime contractor role is for Europe’s Future Combat Air System, developing a system of manned and unmanned platforms.

Its main products include the Eurofighter Typhoon swing-role combat aircraft; the A400M, C295 and CN235 airlifters; the A330 Multi-Role Tanker Transport; along with robust, dependable unmanned aerial systems (UAS).

Airbus also announced in February 2022 that it would be testing the propulsion technology for hydrogen airplanes, in a joint operation with CFM – the largest jet engine maker in the world.

In its full year 2021 results, the company reported €52.1 billion in revenue, largely off the back of commercial aircraft deliveries. The Airbus Defence and Space segment saw its revenues fall by 2%.

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Top 20 defence stocks in the world

Here are the top arms-producing and military services companies in the world, by sales figures for 2020.

Source: The SIPRI TOP 100 Arms Companies 2020